John started a real estate company in Indiana. His company has recently begun operations and is beginning to make money. John now wants to strengthen his business; to do this requires the best understanding of the company and it’s working environment. John wants to know the capitalization rate of his company as a whole. This includes net operating income and costs for the financials of the entity.
Net income = $1,000,000 Cost = $250,000
Capitalization Rate = $100,000 / $250,000 = 4
John knows that his capitalization rate is 4. Next, he speaks with his accountant. He finds that, for this industry, John is doing fairly well for himself. He can use the net income, beyond cost of the bank loan he took, to pay down his loan and begin expanding the company on cash flow. This has immense benefits for both John’s growth and profit potential. John begins to compare the capitalization rate with the discount rate that banks take to create expectations for his next capital project.
He is very happy to hear this. John can now find out how he will use the money rather than worrying about what he will do to please his banker. With the future in sight, he can become a forward thinking business owner.
By developing a better understanding about his company, John is more likely to be running a successful and profitable company. The capitalization rate is a good indicator of the overall capabilities of the company. By utilizing the capitalization rate, John now has the overall profits of the company compared with the overall costs of the company. The ratio created is useful for John because it shows that the overall profits of the company is four times that of the overall costs. As said above, John now knows that he can now concentrate on expenditures of money because his capitalization rate is so positive.
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